EU policy deluge hinders banking reform drive

The most disruptive recommendation of the Liikanen commission is the ring-fencing of banks’ retail and trading books. But the jury is out on whether political leaders have the appetite to implement the wide-ranging recommendations amid fatigue and policy co-ordination fears.

The EU-led
Liikanen banking review released this week has shifted the
centre of regulatory gravity in favour of the hawks who want to
break up lenders and separate retail deposit-taking units from
risk-taking investment banking.

Although it would preserve the universal banking model, the
reports other proposals  especially increased
risk-weighting on trading books and real-estate lending
 add to the regulatory momentum to curb systemic risk and
in effect depress banks earnings.

However, the market reaction has been relatively muted
 despite the media attention  given the uncertainty
of implementation both in terms of substance and timing, as
well as
reform fatigue, more generally, amid the flurry of new
rules this year:
Vickers, a banking union, not to mention the implementation
of
Basel III.

The reports most disruptive recommendation is the
ring-fencing of banks retail and trading books. In a bid
to ensnare capital markets-driven institutions and large
universal banks, under the Liikanen proposal, a trading
operation would need to constitute 15% to 25% of total assets
or total more than 100 billion, before being reviewed for
separation by supervisors.

Whats particularly onerous about the Liikanen review is
that trading assets in the available-for-sale portfolio, rather
than just those assets in the held-for-trading book, fall under
the review, despite the fact these assets are likely to be held
for liquidity purposes, rather than being actively traded.

The Liikanen report would capture the majority of the large
banks in France, Germany and the UK  which are subject to
the
Vickers report  while Swiss institutions are outside
the purview of the EU review.

The axe will fall on most of the large EU banks, with the
exception of Austrias RZB, Portuguese Commercial Bank
(BCP) and Germanys SHB Bank, which fall below the stated
thresholds, according to CreditSights. The report is likely to
embolden Crédit Agricoles mission to downsize its
trading activities since it falls under its more
generously capitalized mutual group, according to
CreditSights.

If ring-fencing were adopted, under Liikanens
proposal, it could substantially hike the cost of financing for
the trading bank, since it would be subject to onerous capital
requirements. The Vickers report estimated a 100 basis point to
200bp increase in debt issuance costs for a given trading bank
business over its retail bank.

Finnish central bank governor, Erkki
Liikanen

The jury is out on whether there is government appetite for
ring-fencing in the near-term in France and Germany. Although
German opposition leader Peer Steinbrück has called for
ring-fencing and curbs on trading-related activities 
leaving Deutsche Bank particularly exposed  the German
government has yet to comment.

However, the
hawks now have the leverage, according to Deutsche Bank
analysts: We do not expect Liikanens proposals on
ring-fencing to be implemented into EU law, because we see the
regulatory pipeline as simply too full.

[But with] the combination of the Steinbrück
paper issued last week and this weeks Liikanen report,
the debate has gained momentum in Germany. The government is
likely to take up some elements of the banking separation
proposal with a view to have them incorporated into banking
legislation.

The Vickers and Liikanen reports overlap on a combination of
areas, including: loan-to-value limits for property funding and
better comparability of internal risk models between banks, an
increase in minimum risk-weights for trading assets, as well as
enforcing a
legal separation of investment banking and commercial
banking, under a universal banking model. The idea of the
reports is to ensure monoline banking arms of a holding firm
can be unwound in the event of a crisis, without imperiling
depositors.

French president François Hollande has pledged to
separate retail and investment-banking operations at a time
when French banks trading assets have expanded during the
past year. According to
Bloomberg data, the investment banking units of BNP
Paribas, Société Générale,
Crédit Agricole and Natixis combined equates to $2.64
trillion in trading assets, a 21% jump year-to-June, compared
with Frances $2.77 trillion economy.

French banks trading assets have increased during the
past year thanks to low interest rates that have boosted the
value of interest-rate derivatives holdings. Nevertheless,
under the Liikanen proposal, the deposit-funded banks would
still be able to offer foreign-exchange and interest-rate
hedging products for non-bank customers, while hedging these
exposures on banks balance sheet.

Nevertheless, EU policymakers in-trays are crammed
full of reforms: banking supervision and union;
preserving a single financial market; a centralized fiscal
union; a single bank resolution fund; not to mention direct
recapitalization of banks.

The Liikanen report argues that the proposed reforms can
help turbo-charge the
establishment of the banking union. However, JPMorgan
analysts reckon this proposal is bedeviled by competing
objectives.

The report is at pains to suggest that, while the
proposals are designed for the single market as a whole,
[they] can also help the establishment of a banking
union.

We are not sure what this means in practice, and think
it reflects the confusion the region has about how these two
concepts are to be stitched together. One (Liikanen) is about
changing the rules of the game, the other (banking union) is
about changing the referee  we think these could be
sequenced more coherently.

It is unclear how the UK and EU processes will work
from here, they state. We would hope for some
harmonization, but there is a risk that we end up with multiple
ring-fenced entities within banks based on region and
assets/liabilities. Further, it is unclear to us how the
European subsidiaries of foreign banks will be
treated.

Many a regulatory battle will be left to fight but it looks
like the idea of European banks deploying holding company
structures is here to stay.

Add Your Comment

All fields are compulsory

All comments are subject to editorial review as we are subject to the same regulations adhered to in publishing our own content. For this reason, your comment may not be live immediately, or may not be published.

Magazine

The material on this site is for financial institutions, professional investors and their professional advisers. It is for information only. Please read our Terms & Conditions, Privacy Policy and Cookies Policy before using this site.